Pension
A pension (from pensiō, "payment") is a fund into which a sum of money is added during an employee's employment years and from which payments are drawn to support the person's from work in the form of periodic payments. A pension may be a "defined benefit plan", where a fixed sum is paid regularly to a person, or a "defined contribution plan", under which a fixed sum is invested that then becomes available at retirement age. Pensions should not be confused with ; the former is usually paid in regular installments for life after retirement, while the latter is typically paid as a fixed amount after involuntary termination of employment prior to retirement. The terms "retirement plan" and "superannuation" tend to refer to a pension granted upon retirement of the individual. Retirement plans may be set up by employers, insurance companies, the government, or other institutions such as employer associations or trade unions. Called retirement plans in the , they are commonly known as pension schemes in the and and superannuation plans (or super) in and . Retirement pensions are typically in the form of a guaranteed , thus insuring against the . A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. s, the government, or other organizations may also fund pensions. Occupational pensions are a form of , usually advantageous to employee and employer for reasons. Many pensions also contain an additional aspect, since they often will pay benefits to survivors or disabled beneficiaries. Other vehicles (certain payouts, for example, or an ) may provide a similar stream of payments. The common use of the term pension is to describe the payments a person receives upon retirement, usually under pre-determined legal or contractual terms. A recipient of a retirement pension is known as a or retiree. Types of pensions Employment-based pensions A retirement plan is an arrangement to provide people with an income during retirement when they are no longer earning a steady income from employment. Often retirement plans require both the employer and employee to contribute money to a fund during their employment in order to receive defined benefits upon retirement. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income. Funding can be provided in other ways, such as from labor unions, government agencies, or self-funded schemes. Pension plans are therefore a form of "deferred compensation". A is a type of employment-based Pension in the UK. The is the iconic self-funded retirement plan that many Americans rely on for much of their retirement income; these sometimes include money from an employer, but are usually mostly or entirely funded by the individual using an elaborate scheme where money from the employee's paycheck is withheld, at their direction, to be contributed by their employer to the employee's plan. This money can be tax-deferred or not, depending on the exact nature of the plan. Some countries also grant pensions to military veterans. Military pensions are overseen by the government; an example of a standing agency is the . committees may also be formed to investigate specific tasks, such as the U.S. (commonly known as the "Bradley Commission") in 1955–56. Pensions may extend past the death of the veteran himself, continuing to be paid to the widow. Social and state pensions Many countries have created funds for their citizens and residents to provide income when they retire (or in some cases become disabled). Typically this requires payments throughout the citizen's working life in order to qualify for benefits later on. A basic state pension is a "contribution based" benefit, and depends on an individual's contribution history. For examples, see in the UK, or in the United States of America. Many countries have also put in place a " ". These are regular, tax-funded non-contributory cash transfers paid to older people. Over 80 countries have social pensions. Some are universal benefits, given to all older people regardless of income, assets or employment record. Examples of universal pensions include Superannuation and the Basic Retirement Pension of . Most social pensions, though, are means-tested, such as in the United States of America or the "older person's grant" in . Disability pensions Some pension plans will provide for members in the event they suffer a . This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age. Benefits Retirement plans may be classified as defined benefit or defined contribution according to how the benefits are determined. A defined benefit plan guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan. A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized. Hence, with a defined contribution plan the risk and responsibility lies with the employee that the funding will be sufficient through retirement, whereas with the defined benefit plan the risk and responsibility lies with the employer or plan managers. Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution plans. They are often referred to as hybrid plans. Such plan designs have become increasingly popular in the US since the 1990s. Examples include Cash Balance and Pension Equity plans. Defined benefit plans A traditional defined benefit (DB) plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. Government pensions such as in the United States are a type of defined benefit pension plan. Traditionally, defined benefit plans for employers have been administered by institutions which exist specifically for that purpose, by large businesses, or, for workers, by the government itself. A traditional form of defined benefit plan is the final salary plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the accrual rate. The final accrued amount is available as a monthly pension or a lump sum, but usually monthly. The benefit in a defined benefit pension plan is determined by a formula that can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a Dollars Times Service plan design that provides a certain amount per month based on the time an employee works for a company. For example, a plan offering $100 a month per year of service would provide $3,000 per month to a retiree with 30 years of service. While this type of plan is popular among unionized workers, Final Average Pay (FAP) remains the most common type of defined benefit plan offered in the United States. In FAP plans, the average salary over the final years of an employee's career determines the benefit amount. Averaging salary over a number of years means that the calculation is averaging different dollars. For example, if salary is averaged over five years, and retirement is in 2009, then salary in 2004 dollars is averaged with salary in 2005 dollars, etc., with 2004 dollars being worth more than the dollars of succeeding years. The pension is then paid in first year of retirement dollars, in this example 2009 dollars, with the lowest value of any dollars in the calculation. Thus inflation in the salary averaging years has a considerable impact on purchasing power and cost, both being reduced equally by inflation This effect of inflation can be eliminated by converting salaries in the averaging years to first year of retirement dollars, and then averaging. In the US, specifies a defined benefit plan to be any pension plan that is not a defined contribution plan (see below) where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan. In the U.S., corporate defined benefit plans, along with many other types of defined benefit plans, are governed by the Employee Retirement Income Security Act of 1974 (ERISA). In the , benefits are typically indexed for inflation (known as (RPI)) as required by law for registered pension plans. Inflation during an employee's retirement affects the purchasing power of the pension; the higher the inflation rate, the lower the purchasing power of a fixed annual pension. This effect can be mitigated by providing annual increases to the pension at the rate of inflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent. If the pension plan allows for early retirement, payments are often reduced to recognize that the s will receive the payouts for longer periods of time. In the United States, under the , any reduction factor less than or equal to the early retirement reduction factor is acceptable. Many DB plans include early retirement provisions to encourage employees to retire early, before the attainment of normal retirement age (usually age 65). Companies would rather hire younger employees at lower wages. Some of those provisions come in the form of additional temporary or supplemental benefits, which are payable to a certain age, usually before attaining normal retirement age. Funding Defined benefit plans may be either funded or unfunded. In an unfunded defined benefit pension, no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid. Pension arrangements provided by the state in most countries in the world are unfunded, with benefits paid directly from current workers' contributions and taxes. This method of financing is known as pay-as-you-go. The social security systems of many European countries are unfunded, having benefits paid directly out of current taxes and social security contributions, although several countries have hybrid systems which are partially funded. Spain set up the Social Security Reserve Fund and France set up the ; in Canada the (CPP) is partially funded, with assets managed by the while the U.S. system is partially funded by investment in special U.S. Treasury Bonds. In a funded plan, contributions from the employer, and sometimes also from plan members, are invested in a fund towards meeting the benefits. All plans must be funded in some way, even if they are pay-as-you-go, so this type of plan is more accurately known as pre-funded. The future returns on the investments, and the future benefits to be paid, are not known in advance, so there is no guarantee that a given level of contributions will be enough to meet the benefits. Typically, the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an to ensure that the pension fund will meet future payment obligations. This means that in a defined benefit pension, investment risk and investment rewards are typically assumed by the sponsor/employer and not by the individual. If a plan is not well-funded, the plan sponsor may not have the financial resources to continue funding the plan. Criticisms Traditional defined benefit plan designs (because of their typically flat accrual rate and the decreasing time for interest discounting as people get closer to retirement age) tend to exhibit a J-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employee's career and accelerates significantly in mid-career: in other words it costs more to fund the pension for older employees than for younger ones (an "age bias"). Defined benefit pensions tend to be less than defined contribution plans, even if the plan allows a lump sum cash benefit at termination. Most plans, however, pay their benefits as an annuity, so retirees do not bear the risk of low investment returns on contributions or of outliving their retirement income. The open-ended nature of these risks to the employer is the reason given by many employers for switching from defined benefit to defined contribution plans over recent years. The risks to the employer can sometimes be mitigated by discretionary elements in the benefit structure, for instance in the rate of increase granted on accrued pensions, both before and after retirement. The age bias, reduced and open ended risk make defined benefit plans better suited to large employers with less mobile workforces, such as the public sector (which has open-ended support from taxpayers). This coupled with a lack of foresight on the employers part means a large proportion of the workforce are kept in the dark over future investment schemes. Defined benefit plans are sometimes criticized as being paternalistic as they enable employers or plan trustees to make decisions about the type of benefits and family structures and lifestyles of their employees. However they are typically more valuable than defined contribution plans in most circumstances and for most employees (mainly because the employer tends to pay higher contributions than under defined contribution plans), so such criticism is rarely harsh. The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be an estimate based on economic and financial assumptions. These assumptions include the average retirement age and lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporation in the U.S. So, for this arrangement, the benefit is relatively secure but the contribution is uncertain even when estimated by a professional. This has serious cost considerations and risks for the employer offering a pension plan. One of the growing concerns with defined benefit plans is that the level of future obligations will outpace the value of assets held by the plan. This "underfunding" dilemma can be faced by any type of defined benefit plan, private or public, but it is most acute in governmental and other public plans where political pressures and less rigorous accounting standards can result in excessive commitments to employees and retirees, but inadequate contributions. Many states and municipalities across the United States of America and Canada now face chronic pension crises. Examples Many countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by or other taxes. In the United States, the Social Security system is similar in function to a defined benefit pension arrangement, albeit one that is constructed differently from a pension offered by a private employer; however, Social Security is distinct in that there is no legally guaranteed level of benefits derived from the amount paid into the program. Individuals that have worked in the UK and have paid certain levels of national insurance deductions can expect an income from the state pension scheme after their normal retirement. The state pension is currently divided into two parts: the basic state pension, State Second tier Pension scheme called S2P. Individuals will qualify for the basic state pension if they have completed sufficient years contribution to their national insurance record. The S2P pension scheme is earnings related and depends on earnings in each year as to how much an individual can expect to receive. It is possible for an individual to forgo the S2P payment from the state, in lieu of a payment made to an appropriate pension scheme of their choice, during their working life. For more details see . Defined contribution plans In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, sometimes through the purchase of an annuity which then provides a regular income. Defined contribution plans have become widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of defined benefit plans in the US has been steadily declining, as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan. Money contributed can either be from employee salary deferral or from employer contributions. The of defined contribution pensions is legally no different from the of defined benefit plans. However, because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans (you do not need to pay an actuary to calculate the lump sum equivalent that you do for defined benefit plans) in practice, defined contribution plans have become generally . In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer, and these risks may be substantial. In addition, participants do not necessarily purchase annuities with their savings upon retirement, and bear the risk of outliving their assets. (In the United Kingdom, for instance, it is a legal requirement to use the bulk of the fund to purchase an annuity.) The "cost" of a defined contribution plan is readily calculated, but the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets. So, for this arrangement, the contribution is known but the benefit is unknown (until calculated). Despite the fact that the participant in a defined contribution plan typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers. A defined contribution plan typically involves a number of service providers, including in many cases: * Trustee * Custodian * Administrator * Recordkeeper * Auditor * Legal counsel Examples In the United States, the legal definition of a defined contribution plan is a plan providing for an individual account for each participant, and for benefits based solely on the amount contributed to the account, plus or minus income, gains, expenses and losses allocated to the account (see ). Examples of defined contribution plans in the United States include s (IRAs) and . In such plans, the employee is responsible, to one degree or another, for selecting the types of s toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined s to selecting individual s or other . Most self-directed retirement plans are characterized by certain s, and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age—typically the year the employee reaches 59.5 years old-- (with a small number of exceptions) without incurring a substantial penalty. In the US, defined contribution plans are subject to limits on how much can be contributed, known as the section 415 limit. In 2009, the total deferral amount, including employee contribution plus employer contribution, was limited to $49,000 or 100% of compensation, whichever is less. The employee-only limit in 2009 was $16,500 with a $5,500 catch-up. These numbers usually increase each year and are indexed to compensate for the effects of inflation. For 2015, the limits were raised to $53,000 and $18,000, respectively. Examples of defined contribution pension schemes in other countries are, the UK's personal pensions and proposed National Employment Savings Trust (NEST), Germany's Riester plans, Australia's Superannuation system and New Zealand's KiwiSaver scheme. Individual pension savings plans also exist in Austria, Czech Republic, Denmark, Greece, Finland, Ireland, Netherlands, Slovenia and Spain Hybrid and cash balance plans Hybrid plan designs combine the features of defined benefit and defined contribution plan designs. A is a defined benefit plan made to appear as if it were a defined contribution plan. They have notional balances in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary; a second contribution, called interest credit, is made as well. These are not actual contributions and further discussion is beyond the scope of this entry suffice it to say that there is currently much controversy. In general, they are usually treated as s for tax, accounting and regulatory purposes. As with defined benefit plans, investment risk in hybrid designs is largely borne by the plan sponsor. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce. s are defined contribution plans made to match (or resemble) defined benefit plans. Contrasting types of retirement plans Advocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. This debate parallels the discussion currently going on in the U.S., where many leaders favor transforming the Social Security system, at least in part, to a self-directed investment plan. Financing Defined contribution pensions, by definition, are funded, as the "guarantee" made to employees is that specified (defined) contributions will be made during an individual's working life. There are many ways to finance a pension and save for retirement. Pension plans can be set up by an employer, matching a monetary contribution each month, by the state or personally through a pension scheme with a financial institution, such as a bank or brokerage firm. Pension plans often come with a tax break depending on the country and plan type. For example, Canadians have the option to open a (RRSP), as well as a range of employee and state pension programs. This plan allows contributions to this account to be marked as un-taxable income and remain un-taxed until withdrawal. Most countries' governments will provide advice on pension schemes. History The concept of a pension appeared in the 7th-century as a form of (charity), one of the , under early . This practice continued well into the (8th-13th centuries). The taxes collected in the of an Islamic government were used to provide income for the needy, which were classified as the poor, elderly, orphans, widows, and the disabled. Additionally, Augustus Caesar (63 B.C.–A.D. 14) introduced one of the first recognisable pension schemes in history with his military treasury. This was in an attempt to quell a rebellion within the Roman Empire which was facing militaristic turmoil at the time. This, whilst did ease tensions within the empire, allegedly became one of the main reasons for the Empires eventual collapse as it struggled to finance the extensive support to which it committed itself to. Despite helping the military, the Empire did little to help ordinary systems as the concept of social security came around at a much later time in history, arguably in the primitive form of serfdom in the medieval period (17th,18th and 19th century). Widows' funds were among the first pension type arrangement to appear. For example, of in Germany founded a widows' fund for clergy in 1645 and another for teachers in 1662. 'Various schemes of provision for ministers' widows were then established throughout Europe at about the start of the eighteenth century, some based on a single premium others based on yearly premiums to be distributed as benefits in the same year.' Germany As part of 's social legislation, the in 1889. The Old Age Pension program, financed by a tax on workers, was originally designed to provide a pension annuity for workers who reached the age of 70 years, though this was lowered to 65 years in 1916. It is sometimes claimed that at the time for the average Prussian was 45 years; in fact this figure is due to the very high infant mortality and high maternal death rate from childbirth of this era. In fact, an adult entering into insurance under the scheme would on average live to 70 years of age, a figure used in the actuarial assumptions included in the legislation. Ireland There is a history of pensions in that can be traced back to imposing a legal responsibility on the kin group to take care of its members who were aged, blind, deaf, sick or insane. For a discussion on pension funds and early Irish law, see F Kelly, A Guide to Early Irish Law (Dublin, , 1988). In 2010, there were over 76,291 pension schemes operating in Ireland. Today the has a two-tiered approach to the provision of pensions or retirement benefits. First, there is a state social welfare retirement pension, which promises a basic level of pension. This is a flat rate pension, funded by the national social insurance system and is termed or PRSI. Secondly, there are the occupational pension schemes and self-employed arrangements, which supplement the state pension. United Kingdom striking over pension changes by the government in November 2011}} Until the 20th century, poverty was seen as a quasi-criminal state, and this was reflected in the that imprisoned beggars. During Elizabethan and Victorian times, represented a shift whereby the poor were seen merely as morally degenerate, and were expected to perform forced labour in s. The beginning of the modern state pension was the , that provided 5 shillings (£0.25) a week for those over 70 whose annual means do not exceed £31.50. It coincided with the and was the first step in the to the completion of a system of social security, with unemployment and health insurance through the . After the Second World War, the completed universal coverage of social security. The formally abolished the poor law, and gave a minimum income to those not paying national insurance. The early 1990s established the existing framework for state pensions in the and . Following the highly respected , occupational pensions were covered by comprehensive statutes in the and the . In 2002 the was established as a cross party body to review pensions in the United Kingdom. The first Act to follow was the that updated regulation by replacing OPRA with the and relaxing the stringency of minimum funding requirements for pensions, while ensuring protection for insolvent businesses. In a major update of the state pension, the , which aligned and raised retirement ages. Following that, the has set up automatic enrolment for , and a public competitor designed to be a low-cost and efficient fund manager, called the (or "Nest"). United States Public pensions got their start with various 'promises', informal and legislated, made to veterans of the and, more extensively, the . They were expanded greatly, and began to be offered by a number of state and local governments during the early in the late nineteenth century. Federal civilian pensions were offered under the (CSRS), formed in 1920. CSRS provided retirement, disability and survivor benefits for most civilian employees in the US Federal government, until the creation of a new Federal agency, the (FERS), in 1987. Pension plans became popular in the United States during , when wage freezes prohibited outright increases in workers' pay. The defined benefit plan had been the most popular and common type of through the 1980s; since that time, defined contribution plans have become the more common type of retirement plan in the United States and many other western countries. In April 2012, the Retirement Fund filed for protection. The retirement fund is a type pension plan and was only partially funded by the government, with only $268.4 million in s and $911 million in . The plan experienced low investment returns and a benefit structure that had been increased without raises in funding. According to Pensions and Investments, this is "apparently the first" US public pension plan to declare bankruptcy. Current challenges }} A growing challenge for many nations is . As birth rates drop and life expectancy increases an ever-larger portion of the population is elderly. This leaves fewer workers for each retired person. In many developed countries this means that government and pensions could potentially be a drag on their economies unless pension systems are reformed or taxes are increased. One method of reforming the pension system is to increase the retirement age. Two exceptions are and , where the pension system is forecast to be for the foreseeable future. In Canada, for instance, the annual payments were increased by some 70% in 1998 to achieve this. These two nations also have an advantage from their relative openness to immigration: immigrants tend to be of working age. However, their populations are not growing as fast as the U.S., which supplements a high immigration rate with one of the highest birthrates among Western countries. Thus, the population in the U.S. is not ageing to the extent as those in Europe, Australia, or Canada. Another growing challenge is the recent trend of states and businesses in the United States purposely under-funding their pension schemes in order to push the costs onto the federal government. For example, in 2009, the majority of states have unfunded pension liabilities exceeding all reported state debt. , former executive director of the PBGC (the , the federal agency that insures private-sector defined-benefit pension plans in the event of bankruptcy), testified before a Congressional hearing in October 2004, "I am particularly concerned with the temptation, and indeed, growing tendency, to use the pension insurance fund as a means to obtain an interest-free and risk-free loan to enable companies to restructure. Unfortunately, the current calculation appears to be that shifting pension liabilities onto other premium payers or potentially taxpayers is the path of least resistance rather than a last resort." Challenges have further been increased by the post-2007 credit crunch. Total funding of the nation's 100 largest corporate pension plans fell by $303bn in 2008, going from a $86bn surplus at the end of 2007 to a $217bn deficit at the end of 2008. Pension systems by country system}} }} Pension systems by country: Notable examples of pension systems by country Some of the listed systems might also be considered . * Argentina - * Australia: ** - Private, and compulsory, individual retirement contribution system. ** - Public pensions *Austria: ** * Canada: ** ** ** ** ** * Hong Kong - * Finland - * France: }} ** ** ** * India : ** ** * Japan - * Malaysia - * Mexico - * Netherlands - * New Zealand ** – public pensions ** – Private voluntary retirement contribution system * Poland - * Singapore - * South Korea - * Sweden - * Switzerland * : ** UK pension provision (generally) ** s * United States: ** ** ** * Vanuatu - References Category:Monetary system